Beta
What Is Beta?
For instance, a stock's risk is measured against a benchmark stock index, like the S&P 500 Index in U.S. trading. It's helpful in deciding a stock's volatility relative to the benchmark, particularly during bull and bear markets. For investors, taking a gander at a stock's beta can be key: generally, the higher the beta in a rising market, the higher the return. On the other hand, in a bear market or correction, a higher beta could point to bigger expected loss.
Beta, addressed by the Greek lowercase letter \u03b2, is likewise utilized in the formula for the weighted average cost of capital, which computes a company's cost of capital. This article, however, centers around a stock's beta.
Beta Formula
Beta = Covariance of a Stock's Return With Market's Return/Market Variance
The most effective method to Calculate Beta (Example: Apple and S&P 500)
Likely the best method for computing beta is by means of a spreadsheet due to the tremendous amount of fundamental data. Collecting historical price data for a stock and its benchmark index normally requires getting to a database online. Below is an instance of ascertaining Apple's beta utilizing historical data of its stock price and the S&P 500 Index.
Step 1: Collect month to month data returning five years. Apple's closing stock price accounts for adjustments, including splits, dividends, as well as capital gain distributions. Work out percent change for each. Note: The formula is displayed in the cell and in the field area on the upper left corner of the spreadsheet.
Step 2: Calculate the covariance among Apple and the S&P 500. Covariance measures the stock's relationship to the benchmark index (in particular by means of percentage changes), while variance measures the spread of the benchmark's percentage change in price.
Step 3: Calculate the variance of the S&P 500.
Step 4: Calculate the beta.
The most effective method to Interpret Beta
A few investors and analysts utilize 5-year betas, and data for beta are collected consistently for a long time. Others utilize less years in light of month to month data, and week after week data for 1-year beta.
A beta close to 1 shows that a stock's volatility is average, and its moves are generally in accordance with the market's. A beta greater than 1 shows that the stock's volatility is better than expected. In a bull market, the stock ascents quicker than the market, yet in a bear market, it falls quicker. With a beta of under 1, the stock's volatility is below average. In a bull market, its gains are more slow than the market, while in a bear market, its declines are more slow. A beta of zero means no volatility and no risk.
The 5-year data from mid 2017 to mid 2022 in the Apple-S&P 500 Index model above showed that with Apple's beta at 1.1727, the stock has better than expected volatility. As the market — involving S&P 500 as the benchmark — gained in the 5-year period, Apple did as well. Since both Apple and the S&P 500 rose during the 5-year period, they would be sorted as being in a bull market, and in light of Apple's beta, the table below demonstrates that Apple's stock moved quicker than the market. The "higher the beta, the higher the return" mantra can be shown by Apple's more than 5-crease gain versus the 90 percent gain for the S&P 500 over the 5-year period.
One more interpretation would be that, in light of a beta of 1.1727, Apple's stock was 17.27 percent more unstable than the S&P 500 during the 5-year period. On the other hand, in the event that Apple had a beta of 0.7, it would recommend Apple was 30 percent less unstable than the benchmark. Another interpretation is say that Apple's stock gained 1.17 times more than the market's return.
Beta Value Meaning at a Glance
| Beta | Volatility | Stock's Sensitivity in a Bull Market | Stock's Sensitivity in a Bear Market |
|---|---|---|---|
| Significantly Greater Than 1 | Above Average | Moves Up Faster Than Market | Moves Down Faster Than Market |
| Close to 1 | Average | Moves Up Similar to Market | Moves Down Similar to Market |
| Significantly Less Than 1 | Below Average | Moves Up Slower Than Market | Moves Down Slower Than Market |
How Is Beta Used?
While beta is technical and historical in nature with its emphasis on past prices, a few investors use it as part of a trading strategy betting on the future bearing of a stock. Beta can be utilized as part of an investment strategy utilizing fundamental analysis, which includes checking on a company's financial statement.
Beta can likewise be utilized related to other technical measures of stock price performance, for example, correlation and standard deviation. Correlation compares a stock's price movement to a benchmark index like the S&P 500 or another stock. A correlation of 1 means that the stock and benchmark move in lockstep with one another in a similar bearing while a correlation of - 1 demonstrates they move the other way. While beta is a measure of systematic risk, standard deviation is a measure of total risk.
Where to Invest in Beta Stocks
Asset management firms have exchange-traded funds (ETFs) that emphasis on stocks' betas. The AGFiQ U.S. Market Neutral Anti-Beta ETF from AGF Management is a strategy fund that takes a 50 percent long position in low-beta U.S. stocks and a 50 percent short position in high-beta stocks. One of AGF's premises for the fund is to create positive returns no matter what the market's heading, insofar as low-beta stocks outperform high-beta stocks.
Investors and analysts likewise monitor the S&P 500 High Beta Index, which measures the performance of 100 stocks in the S&P 500 Index generally sensitive to beta, as well as beta indices that attention on companies with more modest market capitalization.
Highlights
- Beta data about an individual stock can furnish an investor with an estimate of how much risk the stock will add to a (probably) diversified portfolio.
- Stocks with betas over 1 will quite often move with more momentum than the S&P 500; stocks with betas under 1 with less momentum.
- Beta (\u03b2), basically utilized in the capital asset pricing model (CAPM), is a measure of the volatility-or systematic risk-of a security or portfolio compared to the market as a whole.
- For beta to be significant, the stock ought to be connected with the benchmark that is utilized in the calculation.
- The S&P 500 has a beta of 1.0.
FAQ
How Do You Interpret a Stock's Beta?
A Beta of 1.0 for a stock means that it has been just basically as unpredictable as the more extensive market (i.e., the S&P 500 index). Assuming the index goes up or down 1%, so too would the stock, on average. Betas bigger than 1.0 demonstrate greater volatility - so in the event that the beta were 1.5 and the index went up or down 1%, the stock would have moved 1.5%, on average. Betas under 1.0 demonstrate less volatility: if the stock had a beta of 0.5, it would have risen or fallen just a portion of a-percent as the index moved 1%.
Is Beta a Good Measure of Risk?
Numerous specialists concur that while Beta gives some data about risk, it's anything but an effective measure of risk all alone. Beta just glances at a stock's past performance relative to the S&P 500 and gives no forward guidance. It likewise doesn't think about the fundamentals of a company or its earnings and growth potential.
What Is a Good Beta for a Stock?
Beta is utilized as a proxy for a stock's riskiness or volatility relative to the more extensive market. A decent beta will, in this manner, depend on your risk tolerance and objectives. In the event that you wish to reproduce the more extensive market in your portfolio, for example by means of an index ETF, a beta of 1.0 would be great. On the off chance that you are a conservative investor hoping to save principal, a lower beta might be more suitable. In a bull market, betas greater than 1.0 will more often than not produce better than expected returns - however will likewise deliver bigger losses in a down market.
